New Twist On Sector ETF Investing

Last month, ProShares, the ETF provider behind various widely known alternative strategies, launched four S&P 500 ETFs, but each excludes an individual sector. The funds are: S&P 500 Ex-Energy ETF (SPXE); S&P 500 Ex-Financial ETF (SPXN); S&P 500 Ex-Health Care ETF (SPXV); and S&P 500 Ex-Technology ETF (SPXT). The funds are a new twist on sector investing. The idea is that investors might want broad exposure to the S&P 500 but would like to underweight a specific sector they don’t want. ETF Report sat down with Michael Sapir, chief executive officer of ProShares Advisors, to discuss the funds and the idea behind them.

This is a pretty simple concept: stripping out a sector from the nine S&P 500 sectors. You’ve launched four, but I presume you’ll eventually roll out a product lineup that strips out all nine sectors. We respond to demand from advisors and others. If we perceive that there is demand there, we will entertain more products.

What’s the motivation behind this? Was there actual demand for it in that regard? This product set came into being like you’ve seen many successful ETFs come into being. We’ve taken a strategy that has been used by institutional investors for a long time; namely, buying a segment of the market or an index, leaving out a sector. And we’ve taken that strategy and we’ve formed an ETF around it to make it simple and obtainable by retail investors. We’ve gotten very positive feedback from the advisor community who have indicated numerous ways they thought they could use a strategy like this.

Could you give me an example of how they would use this strategy? These do what many successful ETFs do, which is take something that may be complicated or difficult to implement and deliver it through one ETF. These products turn sector funds on their head. Typically, an investor would take or buy a sector fund in order to overweight that particular sector in their portfolio. What these ETFs allow you to do is have further control over the exposure you have in your portfolio by allowing you to underweight a sector. So advisors have told us they might use the product, the strategies in a variety of ways.

First, they’ve indicated that they would be using the strategy to underweight a part of the market that they don’t feel good about—just like they would overweight a part of the market that they felt good about. Before these products came along, you would have to buy the S&P 500 and you had to take everything that came with it, whether you believed in all the sectors or not.

For instance, if you felt there was a secular bear market in energy, and that it would continue, but you still wanted the S&P 500, you had no choice but to take the whole thing. Now you can say, “You know what? I want to underweight the energy sector in my client’s port-folio” And this gives you the opportunity to leave energy behind when you buy the S&P 500.

Is this is a cheaper way to do sector rotation? Well, it’s an easier, convenient way of getting to the result of buying eight out of the nine sectors. If you did that, you’d have to buy the eight different sector ETFs and pay a commission for each of those purchases. And then you would have to rebalance the sectors if you were looking to keep the same weighting that they have in the S&P 500.

Like other ETFs have made accessible a lot of strategies that you could otherwise implement yourself, but were inconvenient or difficult or expensive to implement yourself, so do these funds.

It seems to me one of the things that could happen here is investors stripping out their poor performers and thus removing some of the diversification benefits of that, whereas there might be someone who says, “You should just do the opposite; what’s the best performer? Health care. You should strip that.” You certainly could implement that strategy that says, “Energy’s been underperforming for a couple years now.” And let’s say technology has been overperforming. I’m actually going to move out of the sector of the market that has overperformed. So this doesn’t restrict what the strategy should be. It gives you additional tools to implement strategies.

You could also make that argument against 90 percent-plus of the ETFs out there. You could say the same thing about sector funds. You could say the same thing about country funds. You could say the same thing about different market-cap funds. They all give you the ability to make decisions on what exposure ends up being in your portfolio. And you could certainly make a poor decision to go into the wrong part of the market at the wrong time.

Let me toss out there another use that we see for this product line. We see situations where people already have exposure to a sector of the market, and they don’t want additional exposure through their S&P 500 fund. For instance, you may be getting your exposure to a sector of the market through active management. An advisor may be managing technology on his own because that’s an area of the market that he feels he knows well. So he may be going out and buying stocks on his own.

You may have the situation where an advisor has a client who has extensive exposure to a part of the market already if, for instance, he works in the financial sector and has a lot of exposure through his employment, and through compensation plans to this financial sector. A prudent advisor may say he doesn’t need additional exposure, and he shouldn’t have additional exposure to the financial sector.

Are the expense ratios the same on all these? Twenty-seven basis points.

And these first four that you’re rolling out—ex-energy, ex-financial, ex-health care and ex-technology—were these areas that advisors were asking for? These were the areas that we saw the highest amount of initial interest in.

How do you expect to get traction with these products? Do you plan to put these on some of the platforms, like Schwab? Is there anything you can speak to in terms of that? We intend to have a significant marketing push behind these products. We also intend for our sales force to educate advisors on the products. We think that these products have many of the ingredients that make for a product line that can gain traction really quickly. The products are based off of the most popular index on the planet. And they deliver a very intuitive variation to that index.

We talk about launching products here that can be understood on the elevator ride. And I think these products can be understood going from floor one to floor two.